Notably, LUV stock has underperformed the broader market in each of the last four years. Returns for the stock were -8% in 2021, -21% in 2022, -12% in 2023, and 19% in 2024.
In comparison, returns for the S&P 500 have been 27% in 2021, -19% in 2022, 24% in 2023, and 23% in 2024 — indicating that LUV underperformed the S&P in 2021, 2022, 2023 and 2024.
Southwest Airlines reported operating sales of $6.9 billion in Q4'24, up 1.6% y-o-y. The company reported earnings of $356 million in Q4'24 vs. $237 million in the prior year quarter. The adjusted profit per share surged 47% to $0.56 per share, compared to $0.38 in the prior-year quarter.
Below are key drivers of Southwest Airlines' value that present opportunities for upside or downside to the current Trefis price estimate.
Southwest's Fuel Expense for Passenger Travel: As the largest operating expense for any airline, fuel costs have represented roughly 25% of Southwest's revenue on average over the past five years, and stood at 23% in 2024. We anticipate this percentage to remain around 23% in the near future. However, a significant surge in crude oil prices, potentially driving the Trefis Price per Share (Basic) to 27% instead of our current forecast, could result in a substantial downside of over 50% to the Trefis price estimate for Southwest Airlines' stock.
Southwest Passenger Yield: Following a pandemic-induced drop to $0.14 in 2020 and 2021, Southwest's Passenger Yield has rebounded to $0.17 in 2024. Anticipating measures to mitigate increasing competition, we project a steady growth in the airline's passenger yield to $0.20 by the end of our forecast period. Should the carrier's yield surpass these expectations and reach $0.25, it could lead to a significant 25% upside to our Trefis price estimate for Southwest Airlines' stock.
Southwest Airlines (NYSE:LUV) remains a leading domestic carrier in the United States, renowned for its commitment to low fares. This strategy is underpinned by a focus on maintaining efficient operations through its signature point-to-point service model, streamlined onboard offerings with optional add-ons, and strategic fuel hedging programs. These operational efficiencies enable Southwest to offer competitive fares, a key factor in its sustained market presence and appeal to a broad range of travelers.
The point-to-point network, in contrast to the hub-and-spoke system utilized by many major airlines, allows Southwest to optimize the utilization of its critical resources, including aircraft gates and personnel. This efficiency translates into a network that provides frequent and conveniently timed flights at attractive prices across its markets.
The traditional hub-and-spoke model concentrates the majority of an airline's operations within a limited number of central hub cities, with most other destinations connected through these hubs, often requiring layovers. Disruptions at a hub, such as severe weather or security incidents, can have cascading effects throughout the entire network, leading to widespread delays. By strategically avoiding the concentration of operations in major transfer points, Southwest's point-to-point routing enables more direct, non-stop flights, contributing to better control over delays and reduced overall travel times for its passengers.
Southwest Airlines' low-cost business model is a fundamental driver of its success. This model is primarily achieved and sustained through its predominantly point-to-point route network. By minimizing reliance on hubs, Southwest can offer more direct flights and achieve greater efficiency in the utilization of its aircraft, terminal gates, and workforce, resulting in significant cost savings. Furthermore, their exclusive use of the Boeing 737 aircraft fleet contributes to lower expenses in areas such as personnel training, spare part inventory, and maintenance. This efficient, low-cost operation provides Southwest with a substantial competitive advantage, enabling them to offer lower fares that attract passengers from other airlines.
Fuel represents the most significant single expense for airlines, exposing them to the risks of rising crude oil prices. For Southwest Airlines, fuel costs typically account for approximately a quarter of their total operating expenses. To lessen their susceptibility to fluctuations in fuel prices, Southwest employs a strategy of fuel price hedging.
The demand for air travel is strongly tied to the health of the global economy. Consequently, economic downturns or recessions lead to a decrease in the demand for flights, negatively impacting airline passenger numbers. Conversely, sustained growth in the global or U.S. economy fuels an increase in air travel demand, which can allow airlines to raise their fares, improve occupancy rates, and increase their profits.
Airlines, including Southwest, are increasingly focused on boosting their revenue through ancillary services. These include fees for baggage, onboard Wi-Fi access, food, and beverages, among other offerings. To support this growth, airlines are investing in enhancing their product offerings, such as improved in-flight Wi-Fi and entertainment, upgraded lounge facilities, and seats with extra legroom.
Research indicates that North American airlines collectively generate substantial ancillary revenue, ranking among the highest globally. This growth is largely attributed to airlines' more effective merchandising strategies and the expansion of available à la carte services.
Over the last ten years, budget-friendly airlines like Southwest and JetBlue have significantly increased their share of the U.S. air travel market. Looking ahead, we anticipate this trend to continue, with low-cost carriers further expanding their market share as their more affordable fares attract a greater number of passengers.
The U.S. airline sector has undergone considerable consolidation in the past decade, marked by several major mergers and acquisitions, including the combinations of US Airways with America West, Delta with Northwest, United with Continental, Southwest with AirTran, and American with US Airways.
This increased consolidation within the industry has generally led to improved profitability for all airlines. With fewer competitors in the market, the remaining airlines have found it easier to manage capacity growth more effectively. Prior to this period of consolidation, airlines often rapidly increased their capacity in an attempt to gain market share. This aggressive expansion of available seats resulted in an oversupply, which put downward pressure on margins and reduced profits across the board.
Moving forward, we believe that as long as airlines maintain a disciplined approach to adding capacity, the overall profitability of the airline industry is likely to be sustained.
